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Risk return and opportunity cost of capital

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Unformatted text preview: , they may not give the same ranking of projects, which is a problem in case of mutually exclusive projects. Download free ebooks at bookboon.com 26 Corporate Finance Risk, return and opportunity cost of capital 5. Risk, return and opportunity cost of capital Opportunity cost of capital depends on the risk of the project. Thus, to be able to determine the opportunity cost of capital one must understand how to measure risk and how investors are compensated for taking risk. 5.1 Risk and risk premia The risk premium on financial assets compensates the investor for taking risk. The risk premium is the difference between the return on the security and the risk free rate. To measure the average rate of return and risk premium on securities one has to look at very long time periods to eliminate the potential bias from fluctuations over short intervals. Over the last 100 years U.S. common stocks have returned an average annual nominal compounded rate of return of 10.1% compared to 4.1% for U.S. Treasu...
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